Newcomers to the wonderful world of retail investing in the Australian share market are initially far more concerned about buying shares than selling shares. Eventually, however, the time comes to sell and they are confronted with the dreaded issue faced by investors of all types in all countries – how much will the taxman take?
Of course, the taxman taketh only if you have profited from the sale and thankfully, if you lost money in the transaction you can deduct the loss from other the gains made in other sales. All of this assumes you have held the shares sold for more than 12 months – a long-term capital gain. Different tax rules apply to sales of shares held less than 12 months – short-term gains.
Tax calculation is a complicated business and many serious investors leave it up to high-paid accountants. If you have searched the Internet for help on doing it on your own, you have probably found the Australian Taxation Office (ATO) has a helpful publication entitled Personal Investors Guide to Capital Gains Tax, complete with specific examples.
The problem is the examples fail to illustrate how to determine the cost basis – what you paid for the shares less brokerage commissions – when the number of shares sold do not match the number of shares bought in a single trade.
Here is an example of this dilemma. Suppose you did the following:
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• Bought 10,000 Company ABC shares in early 2007 at $0.30.
• Sold 4000 in late 2008 at $.050.
No problem here as you can identify the shares you are selling – from the 10,000 you bought in your first trade in 2007.
Now you do the following:
• Buy another 3,000 at the end of 2008, this time at $0.50.
• Your total share count is 9,000 shares – 6,000 bought at $0.30 and 3,000 bought at $0.50.
• In January 2010, you decide to sell 2,000 shares, this time at $0.55.
So what is your cost basis for the 2,000 shares sold? Can you take an average cost of the two buys? Can you specify the shares sold came from the higher priced purchase at $0.50 to minimise your taxable gain?
The safest thing to do if you are working alone or your accountant claims ignorance is to use the FIFO (first in first out) method. This means you will always deduct from the earliest purchased shares. In this case, you would specify the 2,000 shares sold as coming from the original purchase at $0.30, leaving you with 4,000 shares remaining purchased at $0.30.
Your cost basis is $600, less the brokerage commissions paid for both the buy trade and the sell trade. Let us assume it is $20. Your proceeds from the sale are $1,100, netting a profit of $520 – the sale price minus the purchase price minus the total commissions.
For your information, Australia did not tax capital gains from share sales prior to 1985 and up until 21 September 1999 you could “index” your gain, reducing the amount to account for inflation as measured by the Consumer Price Index (CPI). Shares bought after 21 September 1999 use a simpler discounting method – 50%. In our example then the gain after applying the discounted method is $260.
Although the difference in gains between the shares purchased in 2007 and 2008 would be relatively small, suppose the difference was very large. Could you designate the shares sold as having been from the lot purchased in 2008 versus 2007 to end up with a smaller capital gain?
Confusion abounds here, which you can verify if you spend some time on the Australian stock forums. Consider the following quotation, direct from the ATO:
• Therefore, in calculating the capital gain or capital loss when disposing of only part of an investment in shares or units, you need to be able to identify which ones you have disposed of.
• If you have the relevant records (for example, share certificates), you may be able to identify which particular shares or units you have disposed of.
• In other cases, the Commissioner will accept your selection of the identity of shares disposed of.
• Alternatively, you may wish to use a ‘first in, first out’ basis where you treat the first shares or units you bought as being the first you disposed of.
• In limited circumstances, the Tax Office will also accept an average cost method to determine the cost of the shares disposed of.
Time was when investors had physical certificates for purchased shares held either in their direct possession or at their brokerage office. Since the advent of CHESS (Australian Clearing House Electronic Sub register System), shares are maintained electronically in a database. ATO provides no guidance as to how you could specify shares maintained by CHESS.
In addition, there is no guidance as to what ATO means by “other cases,” where they will accept your selection or the “limited circumstances” where they will accept averaging.
For this reason, even if you consult a good tax accountant, most will advise you to stick with FIFO. Even if you do, record keeping is still a significant issue. Many retail investors begin their share market investing careers with full-service brokerage houses and later switch to online trading platforms where they do their own trading. The difference in commissions is significant. Brokerage houses transfer their CHESS records for your account into the online service you select so it may be difficult to identify commissions paid once that is done.
Even if you make as few as 10 trades a year, you have record-keeping options to keep you from sorting through account statements, which are not always helpful in terms of cost basis, at tax time.
First, you can configure an Excel spreadsheet or customise Quicken for your own use. However, neither frees you from the cumbersome task of recording the appropriate information at the appropriate time.
A very attractive alternative is available from a few Australian online brokerage houses – special software that tracks your gains for you, using your trading activity as it happens.
E*TRADE in Australia has a basic free service and two more sophisticated offerings for a fee. OptionsXpress in Australia offers its investors Gainskeeper Software, also for a subscription fee.
The example we used above was for a few trades on a single stock. The headaches involved with calculating capital gains for multiple trades made over multiple years should be obvious. Any retail investor who has faced that task may consider the subscription fee towards a software program that tracks your gains to be money well spent.